325_Supplement10 - Department of Economics University of...

Intermediate Macroeconomic Analysis Spring 2011 1 Department of Economics University of Maryland Economics 325 Intermediate Macroeconomic Analysis Supplement 10 Professor Sanjay Chugh Spring 2011 The following symposium, which appeared in the Wall Street Journal on September 9, 2010, collects short essays by several leading monetary economists and macroeconomists offering their views the most prudent short- and medium-term paths for monetary policy to follow. You should be able to use the monetary frameworks we will begin studying in Chapter 14 to understand the channels by which “conventional” interest-rate policy can affect aggregate demand as well as how “quantitative easing” programs more broadly defined can affect aggregate demand. The joint fiscal-monetary framework of Chapter 15 offers an analytical framework with which you should be able to understand Mishkin’s analysis of debt monetization.

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Intermediate Macroeconomic Analysis Spring 2011 2 OPINION SEPTEMBER 9, 2010 What Should the Federal Reserve Do Next? Near-zero interest rates and unprecedented asset purchases by the Fed have failed to return the U.S. economy to robust growth. Editor's note: A prolonged period of near-zero interest rates and unprecedented asset purchases by the Federal Reserve has failed to return the U.S. economy to robust growth or make an appreciable dent in unemployment. It is now commonly asserted that the Fed is "out of ammunition." Is it? We asked six authorities on monetary policy what the Fed should do next. • John B. Taylor: Return to Rule-Based Policy • Richard W. Fisher: Uncertainty Causes 'Liquidity Hoarding' • Frederic S. Mishkin: Don't Monetize the Debt • Ronald McKinnon: Avoid the Zero Interest Rate Trap • Vincent Reinhart: Treasury Purchase Shock and Awe • Allan H. Meltzer: Focus on the Long Term Return to Rule-Based Policy By John B. Taylor To establish Fed policy going forward, the best place to start is to consider what has worked in the past. During the two decades before the recent financial crisis, the Fed employed a reasonably rule-based strategy for adjusting the money supply and the interest rate. The interest rate rose by predictable amounts when inflation increased, and it fell by predictable amounts during recessions. Economists cite the Taylor rule—which says that the Fed's target interest rate should be one-and-a-half times the inflation rate, plus one-half times the shortfall of GDP from potential plus one—as evidence that this approach worked. Performance was good during the 1980s and 1990s when policy was close to the rule. And it was poor when policy was far away from the rule, as it was during the 1970s and the Great Depression. Unfortunately, leading up to and during the recent crisis, the Fed deviated from

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